SJP - VCT Guide

37 36 SUITABILITY SUITABILITY Suitability is a large and important topic, and what follows are guidelines to bear in mind when considering whether a VCT investment is a suitable investment for a client. Investments into smaller, unquoted companies are high risk and Partners need to spend time thinking about suitability and documenting the thought process in suitability reports when recommending a VCT. FCA classification VCTs are classified as alternative investment funds and retail investment products. A Partner who wants to advise their client to invest into a VCT requires retail permissions to advise on securities. They will have to determine whether an investment into listed securities is suitable for their client. Further information on legal and regulatory status is also set out on page 35. Tax capacity Although tax benefits alone should not be the primary driver for the investment, a prospective investor is likely to be an individual who is in a position to take advantage of the tax reliefs available from investing in VCTs. Therefore, if they are planning to purchase newly-issued shares in a VCT, the client should have an income tax liability that could be offset by the upfront income tax relief available for VCT investors. They should not invest more than is needed to address this. The client should also be aware that the tax reliefs can be withdrawn and that the shares might, at some point in the future, be worth less than they initially cost, although, where the reliefs are retained, income tax relief can limit losses. Attitude to risk In general, a VCT investment is likely to be suitable for clients with a high tolerance for risk. Where succession planning is relevant, you should also make the client’s intended heirs aware of the risks involved. While some VCTs may be riskier than others, all VCT investments should be considered as carrying the potential of a capital loss for investors. While this will never be a 100% Suitability The FCA rules on suitability reports require that Partners: √√ Specify the client’s demands and needs. √√ Explain why the firm has concluded that the recommended transaction is suitable for the client, having regard to the information provided by the client. √√ Explain any possible disadvantages of the transaction for the client. capital loss when the income tax relief is taken into account (if it isn’t withdrawn for some reason), and while it may be that, given time, the VCT will recoup any losses, clients should be comfortable taking on this level of risk with the funds they have allocated to VCT investing. Capacity for loss If a loss of the capital they have earmarked for VCT investment would have a materially detrimental effect on the client’s standard of living, then they should be advised against investing in VCT shares. A Partner must detail how capacity for loss has been established. Some of the variables to consider when demonstrating a client’s ability to absorb falls in the value of their investment are as follows: • Client’s age; • Investment time horizon; • Number of years before retirement (ability to make up any losses incurred); • State of health; • Number of dependants; • Income and expenditure; • Amount of savings (including emergency funds); • Amount of debt. Attitude to risk and capacity for loss should be assessed independently of each other. They measure the risk an individual is willing to take (attitude to risk) and the risk an individual can afford to take (capacity for loss). Attitude to risk is subjective and based on a client’s personal opinions. This differs to capacity for loss, which is objective in nature and based on fact. It is also worth remembering that CGT loss relief is not available should the shares be sold at a loss. Suitability Client Considerations Reduce or eliminate income tax liability up to £60,000 They have a requirement for tax-efficient investment for capital growth OBJECTIVES They have a requirement for tax-efficient investment with tax-free dividends They have surplus capital They are aware of the potential to lose all of the investment They are aware the reliefs could be withdrawn or clawed back CLIENT PROFILE No market for the shares Likely to trade at a discount to the NAV (true value) Five-year holding period to retain income tax relief although a five to ten- year holding period is more realistic Tax relief isn’t an excuse for high risk nature WARNINGS